China slowdown not cause for worry

Data released this week showed China’s economy grew by 6.9 per cent in 2015, compared with 7.3 per cent a year earlier, marking its slowest growth in over a quarter of a century. The Post’s Ananth Baliga sat down with Shang-Jin Wei, chief economist of the Asian Development Bank, to discuss the reasons behind the Asian giant’s economic slowdown and its potential impact on Cambodia.

Is China’s economic slowdown just a hiccup or a sign of something bigger?

Are we seeing a China slowdown? Yes, for sure. China used to grow at double digits and now it is growing at single digits. When the growth rate moves slowly, it will come down progressively over the next 10 to 15 years, until it reaches something like 3 to 4 per cent.

Are we seeing a collapse, which some people are saying? China’s growth rate last year was 6.9 per cent. If it becomes 2 per cent this year there will be a collapse in the growth rate, but it is very unlikely we will see an event like this. Instead we are likely to see a gradual slowdown.

Is it too early to gauge what is happening?

The slowdown is understandable and driven by fundamentals. There are two important fundamentals in this context, one is labour costs and the other is demographics.

Chinese labour costs in terms of local currency are higher today than five or 10 years ago. That’s good for anyone who earns a wage, but means many sectors that China used to be globally competitive are less so today.

An example of this is low-end garments. While China has been dominant supplier of garments to the world market, today it is still number one, but market share is sinking. Other countries with lower labour costs have the potential to pick up that market share, and some of them are doing that.

The second fundamental is demographics. China for forty-some years till 2010 had an unusually favourable demographic structure. The ratio of working-age people to people dependent on working-age people – like children and retirees – was unusually favourable for China, partly because of its family planning policy.

But starting from 2011, China switched to an unfavourable demographic for the same reason, because in the preceding decades too few children were born. Therefore, too few people were entering the labour force while their parents and grandparents were retiring. So therefore the ratio of working-age people to dependents becomes unusually unfavourable to other countries.

So what does China need to do to reverse this slowdown?

It has to switch what it was good at and find new ways to grow. The new ways to grow have to be based more on innovation and productivity improvement. These two things are intrinsically harder than growth based on wage costs.

What are the implications of China’s slowdown on other countries in the region?

In terms of affecting other economies, there are two broad categories. The first is countries or country sectors that are expected to be negatively affected by the change in the China economy. This would be countries that produce commodities like oil, silver and copper.

In the last two decades, China has been a voracious importer of commodities – the single largest contributor to incremental demand for commodities. If you happen to produce commodities and commodity revenues are your principal source of budget revenue then this is a difficult time for you to adjust.

The second type of country to be affected negatively by this is countries that export parts and components to China.

There are few scenarios where countries can potentially benefit from this slowdown, but one would entail countries that compete with China in the garment market. China has been the leading garment exporter, but there are other countries that also do garment exports. Cambodia is certainly one, Vietnam, Bangladesh and Myanmar are the others.

In principal, consumers are not wearing fewer clothes, in fact they are wearing more. So demand for clothing is not coming down. So if China is producing less of this, other countries will produce more, mathematically speaking. It is not automatic that orders will come to you; you have to compete for it.

So we are seeing Bangladesh and Vietnam increasing their garment exports. Cambodia certainly has the potential to do the same, given that it has even lower labour costs than Vietnam. In principle, Cambodia can do better than Vietnam. But again it’s not automatic.

How do you expect the slowdown to affect Chinese investments in Cambodia?

FDI does not only bring in capital, but also know-how and marketing channels, so it will shorten the learning [curve] for Cambodian workers and firms and they can market their goods and value-added to the world market more easily. Chinese manufacturing firms used to do this, but now they cannot do it on a cost-competitive basis. So if they want to do it here it will create employment and future entrepreneurship. Those who work in Chinese garment or electronics factories will know how to run a factory, and someday they may run their own firms. That’s a very good thing.

Real estate investments have two sides – on the one side there is still money coming in. When international investors come into buy properties it will bid up prices, which raises the wealth level of Cambodian citizens who used to own those units. So the ones who benefit are the ones who own properties. But for others, like younger people who currently do not own property, the price is getting higher. So there is a trade-off.

With the yuan’s depreciation, what potential impact do you see on Chinese tourist arrivals?

Myanmar and Vietnam are also popular tourist destinations, so relative to these places the cost in Cambodia has increased. By itself this cannot be a positive for tourism. But on the other hand, Cambodia’s absolute cost is still very competitive. For hotels, food and other things it is still very inexpensive.

So the yuan’s depreciation will have a moderate negative effect. People are still looking for international holiday destinations and tend to favour destinations that are well known – and Angkor Wat is extremely well-known in China.

In addition to China’s woes, there are concerns that the US rate hike last December could result in capital flight from developing economies. Should Cambodia be worried?

What people are worried about is that rate changes don’t come in isolation and tend to be followed by a sequence of change in the same direction. In terms of its impact on Cambodia and developing nations in general, there are three scenarios.

The first scenario is that the US increases rates only when it decides the economy is stronger than previously thought. The US does not want the next increase in rates to cause a recession. A stronger US economy means stronger demand for imports, potentially including imports from China, so that is a good thing.

The second scenario is capital flow reversal. Now, this scenario is comparatively less important for Cambodia than for India or Indonesia.

But the third scenario is very important – the exchange rate scenario. Often when US rates increase the US dollar tends to appreciate against other currencies. That scenario can potentially be very important for Cambodia because the economy is very dollarised and even the local currency is maintained at a very tight exchange rate with the US dollar. So when the US dollar appreciates against most other currencies, including those of Vietnam, Bangladesh and Myanmar, the exporting industry in Cambodia becomes less competitive.

The country should be looking at if something can be done about the degree of the economy’s dollarisation and the linkage between the dollar and local currency.